A senior business reporter at the South China Morning Post looks at China's bid to reduce liquidity China's central bank announced over the weekend that the reserve requirements for mainland banks would rise by half a percentage point to 11 per cent of deposits. It raised the requirements again in order to help cool the economy, which has been growing at such a rapid rate that economists worry it could cause a strain on the banking system. EMERGENCY SUPPLY Raising the reserve requirement is like your parents telling you to carry less of your allowance in your wallet. Instead of being able to take 89.5 per cent of your allowance in cash each week, put it in your wallet, and spend it as you wish, you will now only be allowed to take 89 per cent, and the rest has to be kept in the bank in a savings account. This is to ensure that you have an emergency supply of money in a safe place. If you put HK$100 into a savings account, the bank will promise to look after it and give it back when you ask for it. But the bank doesn't just lock up the HK$100 for safe keeping. It finds someone that needs to borrow money to start a business, buy a house, or send their children to school. It takes your HK$100, plus the deposits from other customers, and lends it out at a fee. That's how banks make money. On the mainland, banks have huge deposits because many people there are putting all their money in the bank instead of investing in the stock market, which is a relatively new idea for many mainlanders. But there is also huge demand from borrowers, because China is growing fast. Businesses are borrowing money so they can build bigger factories, develop high rises and open new export markets. MOPPING UP LIQUIDITY And banks have been very busy lending money to them. Mainland banks lent 1.4 trillion yuan in the first quarter, which was almost half as much as they lent all of last year. This is called high liquidity. It's relatively easy to borrow money from banks these days, since they have huge deposits, and strong economic growth makes them confident that you will pay them back. But the mainland economy is growing faster than the government would like, and one reason is there is so much money available. The government wants to reduce the amount of money, or liquidity, in the banking system. By telling banks that they have to keep more of their deposits in their vault and not lend it to their customers, the government, acting through its central bank, hopes to cool down the economy. If you want to buy a house, but it's getting tougher to borrow money, it will likely make you less eager to buy a house, or you'll hunt around longer for a better deal. If this happens in all areas of the economy, prices rise more slowly and businesses expand more cautiously. Raising the reserve requirements also ensures that if the economy turns sour, the banks will be better prepared. The banks know that not everyone will repay their loans; that's one of the risks of the business. Based on how well the economy is doing, they predict how many of the loans will be repaid, and they will take money from their reserves to replenish unpaid loans. By forcing banks to raise the amount they have in reserves, the central bank is making sure that the banks can survive a larger market crash.